Geithner’s “Stress Test” for Banks, and a Stress Test for America

The only way to make sense of Tim Geithner’s “stress test” for banks is to assume a kind of triage. Banks that are reasonably healthy right now — whose assets are fully adequate to fund their liabilities, and can make new loans — don’t need a bailout. And banks that are too far gone to save –- whose loans when realistically valued won’t make them solvent even when the economy recovers — shouldn’t be bailed out. They should be put under receivership that pays off depositors, wipes out shareholders, and then closes the bank.

This leaves a third category of bank that could be salvaged — whose assets are likely to be enough to make them solvent when the economy turns up again — but that need bailouts in the meantime. Money from the Treasury and Fed will be used to lure outside investors to buy up these banks’ bad loans and clear up their balance sheets so they can make new, responsible loans.

At least, that’s the only sense I can make of it.

But how much of our financial system falls into the “too-far-gone-to save” category, and how much into the “might be saved with taxpayer help?” And how will Geithner and his colleagues at the Treasury be able to tell? After all, we got into this mess because banks were fiddling with their numbers and making bets off their balance sheets. And most still aren’t willing to write down their bad loans to realistic market values.

It would be far cheaper, quicker, and safer for the government to just take over every questionable bank. This is the only way we can get the truth about which should be shut down. And the way taxpayers who will be bailing out salvagable banks can ever recoup our costs. Why should any upside gains go to private shareholders who made bad bets or to bank executives and directors who got us into this mess in the first place?

Meanwhile, the rest of America could stand a stress test on a much bigger scale. No need to worry about families with adequate assets to get them through the storm. And the stimulus will help many others. But families that have lost their savings and are within a few years of retirement, or whose breadwinners have been out of work for months and have exhausted their unemployment benefits, or have no health insurance, or who are on the verge of losing their homes – may not make it. Instead of rewarding executives of insolvent banks that would otherwise fail, we should be helping insolvent families for whom failure spells disaster.

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